A very warm welcome to Module 3 of our Cost Accounting course. Module 3 is on cost-center accounting. Cost-center accounting is one of the three subsystems of any cost accounting system. It's actually in the middle of this cost accounting systems. When you've answered the question; which costs have been incurred, you want to know where do these costs show up? That is exactly the task of cost-center accounting. Many, in particular Germany, companies tend to have a very detailed cost accounting system with a lot of cost centers. German companies tend to have small cost centers, 5-10 employees for each cost center, and manage the costs through these cost centers. They are different from many, let's say, US-based enterprises. US-based enterprises tend to have much larger cost-centers, they call them cost departments, and they do not manage these cost centers on such detailed level like German companies typically do. Cost centers can be very efficient when it comes to bringing costs down because you have one person responsible for the cost center, the cost center manager. If you basically plan costs, then you can very easily bring down cost reductions within an organization by simply asking people in your organization to better control the costs on the level of the cost centers. Now we have a closer look on the basic requirements when it comes to the definition of cost centers. One important structural element is that your cost drivers within the cost center are relatively homogeneous. What does that mean? Consider an accounting department. Within the accounting department, the major cost driver might be the number of bookings that you have. Or consider a manufacturing department. Within a manufacturing department, the important cost driver might be the number of products that you produce. If you have one single cost driver, that allows you to basically create a single cost center, the cost driver should be relative homogeneous. It should also be a match between the assignment of responsibilities, so cost centers should have basically their reflection in the organizational design of a corporation. You should define the cost centers in a way that all the company is basically covered by their number of the cost centers. You should not have parts of the company where you do not have any cost centers. Basically, depending on how big the benefits and the costs are of each individual cost center, you should apply a cost and benefit criterion, which basically means that you should only create cost centers if the benefit exceeds the cost. Many startup companies typically do not have any cost centers because they say, we don't need that, we have full overview over the costs. When companies get larger, when you exceed, let's say, 100 employees, then you typically start implementing cost centers because then this structural definition allows you to have a better control of cost. When you want to define cost centers within your organization, you can use two different criteria; either you use the business function of the departments, such as manufacturing, sales, research and development, or you use the distance, how far costs are away from the individual products. If you use the first criterion, you end up with cost centers that are basically defined around the different business functions. Here is an example. You have a company where you find cost centers around energy, building, maintenance, material, manufacturing, administration, sales and distribution, reflecting different business functions of that company. That is a reasonable criterion for defining cost centers. Even if you use this criterion, you might have an additional criterion that basically tells you how far away is your cost center from the products that you manufacture. Direct costs centers include cost centers that are relatively close to these products. Indirect cost centers are those that are relatively far away. It's clear if you have an energy cost center that produces energy for the entire company, then it is not that clear how much of this cost of this energy cost center should be allocated to an individual product. You treat that as an indirect cost center, while the manufacturing department is relatively close to the products that have been manufactured. Here you can treat it as a direct cost center.
